Investors’ Chronicle: Bellway, Hurricane Energy, Tristel

BUY: Bellway (BWY)

The housebuilder believes annual completions can hit 18,000 later in the decade, writes Alex Newman.

Savills estimates that pre-Covid completion volumes will not return until 2026, when build to rent, shared ownership and First Homes schemes finally fill the gaps left by Help to Buy. Even then, Savills estimates the industry will fall a fifth short of the government’s commitment to build 300,000 new homes a year.

Against these tempered projections, Bellway looks like an outlier. Alongside well-trailed preliminary numbers, the housebuilder set out a volume-led strategy to grab an ever-larger piece of Savills’ slow-rising pie. This year, management plans to improve upon the 10,138 homes completed in the 12 months to July by 10 per cent, and believes output of 12,200 in full-year 2023 is achievable.

Armed with a land bank that has swelled 26 per cent in two years to 86,571 plots, the group now sees “substantial capacity” to increase home completions to as many as 18,000 per annum later in the decade.

The rub for investors is whether greater volume will spark a sharper increase in operating profits. A 4 per cent expected dip in the average selling price for the coming year, set against ongoing cost inflation, doesn’t feel like the strongest starting point. Analysts at Jefferies described a “normalised” operating margin target of 18 to 19 per cent, before inflation, as “reassuring [but] unlikely to excite”.

Indeed, long-term shareholders may still view the company as recovering: last year’s 12.4 per cent post-tax return on equity, while commendable given winter lockdowns, is a big drop from the 19.8 per cent recorded in 2019. In 2017, it was 22.6 per cent.

Still, a new target for cumulative underlying pre-tax profits of £1.25bn over the next two financial years came in 4 per cent above consensus and will allay some nerves. Given Bellway has set aside £124m for remedial fire safety costs in the past two years, expect a lower statutory equivalent.

Consensus forecasts are for earnings of 371p per share this year, and 400p for the 12 months to July 2023. At the current price, the shares also trade in line with the consensus forecast book value for July 2024, suggesting analysts anticipate shareholder equity can rise at the same time as dividends.

As we have previously argued, this lowly rating leaves room for missteps, some unexpected headwinds, and solid returns.

SELL: Hurricane Energy (HUR)

The North Sea producer has improved its balance sheet due to the higher oil price, but still has hurdles ahead, writes Alex Hamer.

Six months ago, Hurricane Energy’s directors had effectively given up and asked investors to back a plan to hand the vast majority of the company to creditors to avoid a potentially worse fate.

The vote failed, and a court backed the shareholders. There has been some further intrigue since then, featuring more court judgments and a disputed director, but macroeconomic events have overtaken the drama.

Higher oil and gas prices have sent Hurricane’s cash flow surging, and last month the company bought back a third of its outstanding bonds for $62m (£45m), saving $22m in future obligations to bondholders, it said. The board is now more confident the company will survive a “funding gap” when the rest of the payment on the bonds comes due next year. 

It’s not all rainbows, according to chief executive Antony Maris. “The challenge of funding investment in our assets remains,” he said. With oil at over $80 a barrel (bbl) and likely to stay at higher levels than last year into 2022, that problem may be solved as well. However, the company has to work out how to hang on to the Aoka Mizu floating production storage and offloading ship beyond June and the regulator wants more decommissioning liabilities, which seems justifiable given the company’s shakiness this year. 

Production in the first half was an average of 11,000 barrels of oil per day (bopd), down on the first half of last year, but the average barrel sold for twice as much as it did in 2020, at $62.20/bbl. Costs also climbed over a third, to $25/bbl, but the higher price more than covered this. 

Consensus forecasts compiled by FactSet see full-year free cash flow at $56m, compared with an outflow of $7.5m last year. 

Things are looking up for Hurricane, but if the board cannot invest in maintaining production or hand out a dividend there are better options in the sector.

HOLD: Tristel (TSTL)

The disinfectant specialist has reset its timetable for a key US product launch, writes Alex Newman.

After an operationally challenging pandemic – in which sales teams were prevented from visiting hospitals, outpatient departments were emptied, and purchase orders turned lumpy – disinfection products specialist Tristel is hoping to wipe the slate (as well as diagnostic equipment) clean.

“For the first time in 18 months, we are confident that our normal predictable pattern of business has resumed,” says chief executive Paul Swinney. Investors did not share the optimism, pushing the somewhat illiquid stock down 5 per cent on the publication of full-year numbers.

A couple of details likely explain the sour reception. The first was a £0.8m fair value impairment to a stake in Israeli medtech company Mobile ODT, after an effort to sell the business earlier this year fell flat. The investment, which has declined in value value to £5.4m from £7.1m a year ago, was initially pitched as a beachhead in Tristel’s push into AI-led gynaecology services.

Swinney now says “in hindsight, we wish we hadn’t” pursued the investment, whose write-down accounts for just under a third of the fall in statutory profit and most of the 2.5 per cent dip in shareholder equity.

Another reason for tempered expectations is a “definitive” timetable for long-awaited US expansion. Pending the recruitment of two or three clinics for patient evaluation studies, management now hopes its key Duo for Ultrasound product will be submitted to the Food and Drug Administration (FDA) by the end of this financial year and approved by June 2023. Broker finnCap expects sales to follow in full-year 2024, a decade after entry into the US market was first plotted.

It has, to put it bluntly, been a long road, although Tristel’s sale of surface disinfectant products in the world’s largest healthcare market could soon gain scale. Approvals for Duo’s use as a medical device disinfectant in India, South Korea and Canada all offer further growth promise, in addition to recovering and recurring revenues closer to home.

Consensus forecasts are for earnings per share of 10.5p for the 12 months to June 2022. That estimate is down 30 per cent since the start of this year, and full-year 2023 expectations have scaled back from a 19.7p peak to 16.3p. As such, and even after a recent pullback, Tristel’s shares trade at a near-50 per cent premium to their historic five-year forward price/earnings multiple of 34.

With hindsight, it’s hard to find fault with the latter rating, given net income climbed by an average of 18 per cent a year during that period. But FDA timetables are central to the next re-rating opportunity.

Chris Dillow: Wanted: an exit strategy

Investors need some kind of disciplined selling strategy.

I say this because of a point I made recently – that the ratio of the world’s money stock to share prices suggests that the latter are overpriced.

This gives us a nasty dilemma. On the one hand, there are reasons to doubt this claim. It’s possible that the high prices of big US tech companies are sustainable because they have the monopoly power to generate ongoing earnings growth; this is a big difference between now and the tech bubble of the late 1990s. And even if equities are overpriced, it does not follow that they will fall soon. Asset price bubbles develop momentum, such that big returns are sometimes to be made just before prices peak.

On the other hand, though, when bubbles do burst the losses can be calamitous. After Japanese shares peaked in 1989 the market halved in the following three years. The Nasdaq composite index lost 70 per cent between 2000 and 2002. And UK shares halved between 1928 and 1948 after inflation.

Being in top-quality companies is no protection against such losses. During the 2000-02 crash Apple fell more than 70 per cent and Amazon more than 90 per cent. When bubbles burst, they drag down even the best stocks. Nor are these losses quickly recovered.

Hence our problem. There is a danger that global equities are in a bubble that’s likely to deflate some time and if it does the losses will be horrible. We can’t quantify this risk or say when it will materialise. But risk is probability multiplied by impact — and the potential impact is big.

There might well come a time when we need to get out of equities, therefore, even if that time is not now.

Herein, though, lies a danger. There are always powerful motives to stay in overpriced equities. Bubbles don’t suddenly burst. They deflate slowly because investors are slow to sell and often slow to change our minds when the facts change.

If these motives stop us selling during the early phases of a deflating bubble another kicks in later. We hate admitting, even if only to ourselves, that we are wrong: selling at a loss is an admission of failure, something we are loath to do.

Such motives mean it’s easy to stay in a deflating market all the way down.

What we need is some rule that tells us when to sell in response to changing market conditions. One such rule is of course to sell when prices fall below their 10-month moving average, as first advocated by Meb Faber at Cambria Investment Management.

This rule isn’t perfect. It never gets us out of the market right at the top or into it at the very bottom. And it loses us money in those circumstances where a strategy of buying on dips works.

For all its drawbacks, however, it has one huge merit. It protects us from the long and deep bear markets which happen when bubbles deflate and which can really destroy our wealth. It is for this reason that the rule would have delivered better long-run risk-adjusted returns than a buy-and-hold strategy in markets as various as Japan, the US, UK, emerging markets and mining stocks. If you want to avoid the worst that can happen to investors, you need something like this kind of rule.

There are alternatives such as various types of adjusting stop-losses. There’s no point looking for an optimum rule: what worked best in one market or period won’t necessarily work best in another. What we do need is a rule that’s good enough to protect us from the sort of terrible losses that happen when bubbles deflate — because we know for sure that neither futurology nor unaided judgment are sufficient protection.

Chris Dillow is an economics commentator for Investors’ Chronicle

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